What is free margin in forex trading?

Why is there a "Free Margin"? One of two categories applies to margin: "utilised" or "free." In a previous lesson, we talked about used margin, which is just the total of all required margin from all open positions.

August 01, 2022 - 04:29 PM 342 views

What is free margin in forex trading

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Why is there a "Free Margin"?

One of two categories applies to margin: "utilised" or "free."

In a previous lesson, we talked about used margin, which is just the total of all required margin from all open positions.

The difference between equity and used margin is the free margin.

The equity in a trader's account that is NOT used as margin for open positions is referred to as free margin.

Due to the fact that free margin can be used, it is also known as useful margin.

Two items can be considered as free margin:

·         The number of vacant NEW posts that are open.

·         The amount existing holdings can shift against you before you get a stop out or a margin call.

Concerning what a Margin Call and Stop Out are, don't worry. We'll talk about them later.

For now, just be aware that they are harmful. You don't want to go through them, just like acne breakouts.

Calculating Free Margin

How to Calculate Free Margin is as follows:

Free Margin = Equity - Used Margin

Your equity will rise if you have open trades that are now profitable, which also indicates that your free margin will rise.

Floating earnings raise Equity, and subsequently, Free Margin rises.

Your equity will drop if your open positions are losing money, which also means that your free margin will drop.

Floating losses decrease Equity, which decreases Free Margin.

Example: No Open Positions

Let's begin with a simple illustration.

You fund your trading account with $1,000.

What is your free margin given that you don't have any open positions?

Step 1: Calculate Equity

When there are no unfilled positions, figuring out the equity is simple.

Equity = Account Balance + Floating Profits (or Losses)

$1,000 = $1,000 + $0

 Balance and Equity would be the SAME.

You have no floating earnings or losses because you don't have any open positions.


Step 2: Calculate Free Margin

The Free Margin and the Equity are the SAME if you don't have any open positions.

Free Margin = Equity - Used Margin

$1,000 = $1,000 - $0

There is no margin being "utilised" because there are no vacant spots for you.

As a result, your balance and equity will be equal to your free margin.

Example: Open a Long USD/JPY Position

Let's now add a trade to make things a little trickier!

Let's imagine you have a $1,000 balance in your account.


Step 1: Calculate Required Margin

You want to start a position trading 1 mini lot (10,000 units) of USD/JPY long. The minimum required margin is 4%.

How much required margin (margin needed) will you require to open the position?

Because the base currency is the USD. The Notional Value of the position is $10,000 because this tiny lot is worth $10,000.

Required Margin = Notional Value x Margin Requirement

 $400 = $10,000 x .04

Given that the margin requirement is 4% and your trading account is USD-denominated, your required margin will be $400.

Step 2: Calculate Used Margin

There are no open trades other than the one we just entered.

The Used Margin will match the Required Margin because we only have ONE open position.

Step 3: Calculate Equity

Assume that the price has changed marginally in your favour, bringing your position's price to breakeven.

Thus, your floating P/L is equal to nothing.

Let's figure out your equity.

Equity = Account Balance + Floating Profits (or Losses)

$1,000 = $1,000 + $0

Your account now has $1,000 in equity.

Step 4: Calculate Free Margin

We can calculate the free margin now that we know the equity:

Free Margin = Equity - Used Margin

$600 = $1,000 - $400

There is a $600 Free Margin.


You can see that another way to think of equity is as the total of your used and free margin.

Equity = Used Margin + Free Margin

Recap

We learned the following in this lesson:

The money that is NOT "locked up" because of an open position and can be utilised to start additional positions is known as free margin.

Additional positions cannot be opened while the Free Margin is zero or lower.


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